By Mark Edwards
As a continuation of the Economic Update, today we look at Alaska’s State Government.
State government will have to make prudent spending cuts and raise new revenues - The most impacted sector from a decline in the price of oil is the State of Alaska government. We are the most structurally imbalanced government in the country in terms of the diversification of revenue sources.
Major volatility occurs in State revenues due to two factors outside the government’s control: fluctuations in oil prices and changes in market conditions for our investment portfolios. In fiscal year 2015, 75% of the state’s unrestricted spending came from oil taxes and royalties. The State budget estimates for the price of oil have been set too high and fail to account for the extreme volatility in oil prices that occur regularly. As the price of oil has dropped the current deficits have become even larger than expected.
Earnings from the State’s investment accounts are the only other major source of revenue sufficient to offset the loss of oil revenue. However, they have traditionally been off limits for the government to spend, other than for dividends from the State of Alaska Permanent Fund (Permanent Fund) to residents. Instead, politicians have preferred spending from savings accounts like the Constitutional Budget Reserve Fund (CBRF) to bridge periods of low revenues to cover budget gaps until they are bailed out by oil prices rebounding.
This practice has worked now for decades and it appears many legislators have become complacent. Unfortunately, the paradigm has shifted for two primary reasons. First, the savings accounts are being depleted at a faster rate than ever with deficits of over $3 billion a year. Secondly, oil production has fallen from a peak of 2 million barrels a day in the 1980’s to now approximately 500,000 barrels a day. That means we are more sensitive than ever to low oil prices because we are further straining a diminishing pool of assets, while the size of government keeps growing.
Recent windfalls in oil revenue were a result of not only oil prices hovering over $100 for an extended period, but also from progressive oil tax rates that dramatically increased the State’s share during periods of high prices. These forces masked the continued decline in oil production levels. Lower prices sharply reversed the progressive production tax that the State had become accustomed to spend and made the decline on the downside even more painful.
The State’s Revenue Source book published recently helps quantify this volatility. Total State revenue is derived from four primary sources: petroleum, non-petroleum, investment accounts, and Federal contributions. The Federal take has been a steady $2 billion to $2.5 billion for the last decade. Non-petroleum has been between $0.9 and $1.2 billion since 2006 from sources such as fisheries, tourism, mining, alcohol, tobacco and fuel taxes.
As expected, investment accounts have fluctuated wildly. They have twice returned over $8 billion in the last 10 years, but also lost -$1.3 billion and -$6.6 billion in 2008 and 2009 when the national recession began. Petroleum revenues reached a high of $11.3 billion in 2008 and were a low of $2.4 billion in FY15. When these two categories move in concert the revenue shock can be dramatic. In 2008, total State revenues from all sources totaled $13.1 billion then fell to a low of $2.5 billion in 2009. In 2009, petroleum revenue declined by $5.2 billion from the prior year and investment accounts lost $6.6 billion. In FY14 the State earned a total of $17.2 billion, only to see a 51% drop in total revenues to $8.5 billion in FY15.
Faced with this dire budget situation, the Governor has announced his new “Sustainable Alaska Plan”. The primary goals are to take action now by making cuts to government while protecting essential services. He consents to using Permanent Fund earnings as long as we protect the fund’s corpus and preserve a modified dividend program for residents. The spending cuts he suggests include $600 million in reductions through 2019 and 600 fewer employees compared to last year. This is a bit over 2% of the State government labor force, though most would be from elimination of unfilled positions and attrition. Other changes would come in formula funding programs with increases funded in the short run by higher Federal contributions. The energy tax credit program would be reduced and a new $200 million loan fund would be added to support oil exploration. More of the capital budget would be supported through GO bonds.
The largest change would come from an increased use of the Earnings Reserve portion of the Permanent Fund. New contributions to the fund would come from a one-time transfer of all money in the CBRF, continued transfer of Permanent Fund earnings, and an increase from 25% to 50% of all natural resource revenues. The other 50% would go to pay the dividends, which will reduce the size of dividends.
The last major component of the plan will likely not be addressed for two years. The Governor proposes new taxes for both businesses and individuals. The Governor’s suggestion is to tax 6% of a person’s federal tax liability, which is expected to average about 1% of income for a typical family. There would also be taxes for out-of-state workers, S-corporations and partnerships.
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